NOTE F — FAIR VALUE OF ASSETS AND LIABILITIES

The Company groups its financial assets measured at fair value in three levels, based on the markets in which the assets are traded and the reliability of the assumptions used to determine fair value. These levels are:

Level 1:

Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

Level 2:

Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained from third party pricing services for identical or comparable assets or liabilities which use observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets and liabilities

Level 3:

Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

Following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis and recognized in the accompanying balance sheets.

Available-for-Sale Securities

The fair value of available-for-sale securities is determined by various valuation methodologies. Where quoted market prices are available in an active market, securities are classified within Level 1. If quoted market prices are not available, then fair values are estimated by using pricing models or quoted prices of securities with similar characteristics. Level 2 securities include U.S. Treasury securities, obligations of U.S. government corporations and agencies, obligations of states and political subdivisions, mortgage-backed securities and collateralized mortgage obligations. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy.

The following table presents the Company’s assets that are measured at fair value on a recurring basis and the level within the hierarchy in which the fair value measurements fell as of September 30, 2013 and December 31, 2012 (in thousands):

September 30, 2013

(Dollars in thousands)			Fair Value Measurements Using
			Quoted Prices in Active Markets For Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Fair Value		(Level 1)		(Level 2)		(Level 3)

Obligations of U. S. Government Agencies	$	32,527	$	-	$	32,527	$	-
Municipal securities		110,367		-		110,367		-
Mortgage-backed securities		81,032		-		81,032		-
Corporate obligations		26,918		-		24,135		2,783
Other		969		969		-		-
Total	$	251,813	$	969	$	248,061	$	2,783

December 31, 2012

			Fair Value Measurements Using
			Quoted Prices in Active Markets For Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Fair Value		(Level 1)		(Level 2)		(Level 3)

Obligations of U. S. Government Agencies	$	36,359	$	-	$	36,359	$	-
Municipal securities		98,910		-		98,910		-
Mortgage-backed securities		61,967		-		61,967		-
Corporate obligations		16,187		-		13,519		2,668
Other		970		970		-		-
Total	$	214,393	$	970	$	210,755	$	2,668

The following is a reconciliation of activity for assets measured at fair value based on significant unobservable (non-market) information.

(Dollars in thousands)

	Bank-Issued Trust Preferred Securities
	2013		2012
Balance, January 1	$	2,668	$	2,252
Transfers into Level 3		-		-
Transfers out of Level 3		-		-
Other-than-temporary impairment loss included in earnings		-		-
Unrealized gain included in comprehensive income		115		416
Balance at Sept. 30, 2013 and December 31, 2012	$	2,783	$	2,668

Following is a description of the valuation methodologies used for assets measured at fair value on a non-recurring basis and recognized in the accompanying balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy.

Impaired Loans

Loans for which it is probable that the Company will not collect all principal and interest due according to contractual terms are measured for impairment. Allowable methods for estimating fair value include using the fair value of the collateral for collateral dependent loans or, where a loan is determined not to be collateral dependent, using the discounted cash flow method.

If the impaired loan is identified as collateral dependent, then the fair value method of measuring the amount of impairment is utilized. This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value. If the impaired loan is determined not to be collateral dependent, then the discounted cash flow method is used. This method requires the impaired loan to be recorded at the present value of expected future cash flows discounted at the loan’s effective interest rate. The effective interest rate of a loan is the contractual interest rate adjusted for any net deferred loan fees or costs, or premium or discount existing at origination or acquisition of the loan. Impaired loans are classified within Level 2 of the fair value hierarchy.

Other Real Estate Owned

Other real estate owned acquired through loan foreclosure is initially recorded at fair value less estimated costs to sell, establishing a new cost basis. The adjustment at the time of foreclosure is recorded through the allowance for loan losses. Due to the subjective nature of establishing the fair value, the actual fair value of the other real estate owned or foreclosed asset could differ from the original estimate. If it is determined the fair value declines subsequent to foreclosure, a valuation allowance is recorded through non-interest expense. Operating costs associated with the assets are also recorded as non-interest expense. Gains and losses on the disposition of other real estate owned and foreclosed assets are netted and posted to other non-interest expense. Other real estate owned measured at fair value on a non-recurring basis at September 30, 2013, amounted to $5.3 million. Other real estate owned is classified within Level 2 of the fair value hierarchy.

The following table presents the fair value measurement of assets measured at fair value on a nonrecurring basis and the level within the fair value hierarchy in which the fair value measurements fell at September 30, 2013 and December 31, 2012.

($ in thousands)

September 30, 2013

			Fair Value Measurements Using
			Quoted Prices in Active Markets For Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Fair Value		(Level 1)		(Level 2)		(Level 3)

Impaired loans	$	4,351	$	-	$	4,351	$	-

Other real estate owned		5,292		-		5,292		-

December 31, 2012

			Fair Value Measurements Using
			Quoted Prices in Active Markets For Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Fair Value		(Level 1)		(Level 2)		(Level 3)

Impaired loans	$	3,589	$	-	$	3,589	$	-

Other real estate owned		6,782		-		6,782		-

The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practicable to estimate that value:

Cash and Cash Equivalents – For such short-term instruments, the carrying amount is a reasonable estimate of fair value.

Investment in securities available-for-sale and held-to-maturity – The fair value measurement for securities available-for-sale was discussed earlier. The same measurement approach was used for securities held-to-maturity.

Loans – The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

Deposits – The fair values of demand deposits are, as required by ASC Topic 825, equal to the carrying value of such deposits. Demand deposits include noninterest-bearing demand deposits, savings accounts, NOW accounts, and money market demand accounts. The fair value of variable rate term deposits, those repricing within six months or less, approximates the carrying value of these deposits. Discounted cash flows have been used to value fixed rate term deposits and variable rate term deposits repricing after six months. The discount rate used is based on interest rates currently being offered on comparable deposits as to amount and term.

Short-Term Borrowings – The carrying value of any federal funds purchased and other short-term borrowings approximates their fair values.

FHLB and Other Borrowings – The fair value of the fixed rate borrowings are estimated using discounted cash flows, based on current incremental borrowing rates for similar types of borrowing arrangements. The carrying amount of any variable rate borrowing approximates its fair value.

Subordinated Debentures – The subordinated debentures bear interest at a variable rate and the carrying value approximates the fair value.

Off-Balance Sheet Instruments – Fair values of off-balance sheet financial instruments are based on fees charged to enter into similar agreements. However, commitments to extend credit do not represent a significant value until such commitments are funded or closed. Management has determined that these instruments do not have a distinguishable fair value and no fair value has been assigned.

	As of September 30, 2013				As of December 31, 2012
	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
	(In thousands)
Financial Instruments:
Assets:
Cash and cash equivalents	$	51,764	$	51,764	$	30,877	$	30,877
Securities available-for-sale		251,813		251,813		214,393		214,393
Securities held-to-maturity		8,446		9,441		8,470		7,055
Other securities		4,624		4,624		3,438		3,438
Loans, net		566,841		580,204		408,971		422,029

Liabilities:

Noninterest-bearing Deposits	$	169,001	$	169,001	$	109,625	$	109,625
Interest-bearing deposits		644,964		644,511		487,002		487,599
Subordinated debentures		10,310		10,310		10,310		10,310
FHLB and other borrowings		30,000		30,000		36,771		36,771